Systemic Risk-Taking: Amplification Effects, Externalities, and Regulatory Responses

Anton Korinek

No 2011-WP-13, NFI Working Papers from Indiana State University, Scott College of Business, Networks Financial Institute

Abstract: This paper develops a simple macroeconomic model of systemic risk in the form of financial accelerator effects: adverse developments in financial markets and in the real economy mutually reinforce each other and lead to a feedback cycle of falling asset prices, deteriorating balance sheets and tightening financing conditions. We show that decentralized agents choose to expose themselves to financial accelerator effects to a socially inefficient extent and do not take on sufficient insurance against systemic risk even if given access to a complete ex-ante insurance market. We use the framework to shed light on a number of current policy issues: First, we develop a new analytical framework of macro-prudential capital adequacy requirements that take into account systemic risk by employing an externality pricing kernel. Second, we show that agents employ ex-ante risk markets to fully undo any expected government bailout. Finally, we find that constrained market participants face socially insufficient incentives to raise more capital during systemic crises.

Keywords: financial amplification; systemic risk; systemic externalities; externality pricing kernel; macroprudential regulation; bailout neutrality (search for similar items in EconPapers)
JEL-codes: D62 E44 G13 G18 H23 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2011-05
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (56)

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Related works:
Working Paper: Systemic risk-taking: amplification effects, externalities, and regulatory responses (2011)
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